Why is a college education so expensive?

Published Jun 6, 2010 • Vishal Bardoloi

NY Times points out that higher education costs are rising fast, even during a recession. That's bad news for students and families who took on tremendous debt - because if they can't pay it back (like most students who graduated without a job in 2008-09), bankruptcy is not an option. The article asks a good question: at what point will the cost get too prohibitive?

It's true that Ivy league professors, like Wall Street bankers and Medicare doctors, get paid disproportionately high salaries relative to the benefits they provide to society. I call it the "NASA effect" - despite the trillions of dollars poured into NASA, the list of real societal benefits from that organization is ratherbanal. And yet nobody shuts it down or reins it in, because in the public's mind NASA stands for more... things like national pride and human achievement and mom and apple pie. There's too big a halo around it.

Ditto with an Ivy league education.

So here's the key question: what exactly is all that tuition money buying you? And can you get it cheaper elsewhere?

I've studied at a top-10 institution (grad) and a softer, tier-2 one (undergrad). Here's my breakdown on what I got from the top school:

Trade skills: To be honest, none of the courses I paid for have been relevant in any way since the day I left. Those skills could have definitely been obtained at a cheaper price elsewhere.

Life skills: I did learn a lot of intangible lessons, though. Competing with the best and brightest in the world took me to levels I didn't know I could achieve. Learning from great minds and being inspired by their research was incredibly rewarding. And knowing that I survived and (to some extent) thrived in that environment is something nobody can take away - it's a level of self-confidence that is hard to achieve any other way. That benefit was certainly worth a lot. Maybe there are other cheaper ways to learn those life skills - internships/jobs at top companies, a stint in the armed forces, etc.

Network: There's also the amazing bunch of people I met and befriended. The world has learnt all about the benefits of networking, of course, but there's networking and then there's bonding over a shared experience. Again, not something you can replicate easily. If you've seen two Aggies or two Gators meet, you'll know what I mean.

Brand name: Finally, there's the halo effect that other people bestow upon you for being from a top institution.

Now let's monetize these benefits. Say my overall tuition was $100. And you, as my parent/banker/sponsor, ask me to itemize that bill over these four areas. What would that breakdown look like?

For someone in an Ivy league school, I'd bet the breakdown looks something like 10/40/30/20. That is, the coursework is only about 10% of the total educational value, the life skills about 40%, and the network and brand name are about 30% and 20% respectively. For students in certain fields like finance or MBA, the ratios might actually be closer to 5/35/30/30 (remember, their boardroom politics depends a lot on their MBA alma mater). And here's the kicker: if you change the numbers to reflect their value over your lifetime, they get skewed even further: more like 1/34/35/30.

At the other extreme, for someone going to a trade school, the same ratios might look like 90/5/5/0. They're mainly paying to learn a skill; and they don't expect much from their fellow students or university after they leave. And those numbers won't change much over their lifetime.

(Please note: I'm generalizing here, of course these numbers have no relation to anything in the real world. I'm merely using them for the purpose of this mental exercise).

If you control for the value of the education, then just from these numbers, you can see that an Ivy Leaguer should be willing to pay 10 to 90 times the tuition of someone going to trade school. And when you actually start to factor in things like quality of education, professors' salaries, brand name cachet etc., that number goes up into multiples of 1000.

Marketing 101 says you don't price an item based on how much it costs to produce; you price it based on what the market is willing to pay. Universities know that students are willing to pay through their nose for an entry. Students, in turn, know that the job market will reward them lifelong for having a top degree.

Bottom line, most schools today are trying to strike a balance between what they offer in terms of value and what they charge in fees. But the truth is that when you account for lifetime returns, a college education is still fairly priced - perhaps even underpriced.

Bonus: "Why do professional athletes make so much more money than teachers? Isn't education more valuable to society than entertainment?" Find the answer here.